Busi­ness res­cue curbs up for de­bate

Mas­ter agree­ments put for­ward as an­other ex­cep­tion to in­ter­fer­ence by the pow­ers of res­cue prac­ti­tion­ers

Business Day - Business Law and Tax Review - - BUSINESS LAW & TAX REVIEW - BRID­GET KING

BUSI­NESS res­cue prac­ti­tion­ers have far-reach­ing pow­ers to can­cel or sus­pend any pro­vi­sion of an agree­ment to which a com­pany in fi­nan­cial dis­tress is a party.

One ex­cep­tion to this rule is an agree­ment of em­ploy­ment.

In our view a sec­ond ex­cep­tion is mas­ter agree­ments as con­tem­plated in sec­tion 35B and ex­change traded de­riv­a­tives that fall within sec­tion 35A of the In­sol­vency Act, 1936.

We be­lieve that it must have been the in­ten­tion of the leg­is­la­ture that these trans­ac­tions — such as trades un­der a mas­ter agree­ment, like the 2002 ISDA (In­ter­na­tional Swaps and De­riv­a­tives As­so­ci­a­tion Inc) — are to be safe from sus­pen­sion or can­cel­la­tion dur­ing busi­ness res­cue pro­ceed­ings.

This is a con­tro­ver­sial is­sue as the sec­tion in the new Com­pa­nies Act, 2008 is not as pre­cise as it could be. As it stands, the is­sue is sub­ject to de­bate and the leg­is­la­tion may yet be amended. Sec­tion 136(2) of the 2008 Com­pa­nies Act, says:

“Sub­ject to sec­tions 35A and 35B of the In­sol­vency Act, 1936 … de­spite any pro­vi­sion of an agree­ment to the con­trary, dur­ing busi­ness res­cue pro­ceed- ings, the prac­ti­tioner may can­cel or sus­pend en­tirely, par­tially or con­di­tion­ally any pro­vi­sion of an agree­ment to which the com­pany is a party at the com­mence­ment of the busi­ness res­cue pe­riod, other than an agree­ment of em­ploy­ment.”

When sec­tion 35B of the In­sol­vency Act was amended in March 2005, the ef­fect was to pre­serve pre-and postin­sol­vency net­ting and set off pro­vi­sions con­tained in the mas­ter agree­ments which gov­ern over-the-counter de­riv­a­tive trans­ac­tions in SA.

Sec­tion 35B carves out the de­riv­a­tive trans­ac­tions ex­e­cuted un­der these mas­ter agree­ments so that any net­ting which had taken place pre-in­sol­vency would not be sub­ject to the In­sol­vency Act’s pro­vi­sions re­lat­ing to void­able dis­po­si­tions, void­able pref­er­ences and un­due pref­er­ences.

The liq­uida­tor would have to abide by the net­ting and set off pro­vi­sions of the mas­ter agree­ments. Fur­ther, upon in­sol­vency, all un­per­formed obli­ga­tions un­der the mas­ter agree­ments ter­mi­nate au­to­mat­i­cally, the val­ues of the un­per­formed obli­ga­tions are de­ter­mined at mar­ket value and set off, and a net amount is payable.

Sim­i­larly, sec­tion 35A pre­serves all pre-in­sol­vency set-off, net­ting and close-outs of po­si­tions con­cluded on a stock ex­change in terms of the rules of that ex­change, and all such set-offs, net­ting and close-outs are bind­ing on a liq­uida­tor upon in­sol­vency. Why the de­bate? The pro­vi­sions in the new Com­pa­nies Act pro­vide that the rights of the busi­ness res­cue prac­ti­tioner may only be ex­er­cised dur­ing busi­ness res­cue pro­ceed­ings. By cit­ing sec­tions of the In­sol­vency Act in the clause deal­ing with busi­ness res­cue, the dis­tinc­tion be­tween liq­ui­da­tion and pre-in­sol­vency pro­ceed­ings such as busi­ness res­cue, be­comes some­what blurred.

The anom­aly is that busi­ness res­cue pro­ceed­ings (which are aimed at res­cu­ing the com­pany on a sol­vent ba­sis) must first have failed in or­der for the pro­vi­sions of the In­sol­vency Act to be­come rel­e­vant.

Some ar­gue that the new Compa- nies Act there­fore trumps the In­sol­vency Act and that those par­ties con­clud­ing de­riv­a­tive trans­ac­tions on ex­change or un­der the mas­ter agree­ments are at risk should their coun­ter­party en­ter into busi­ness res­cue pro­ceed­ings, as the prac­ti­tioner may set aside, can­cel or sus­pend any pro­vi­sions of the mas­ter agree­ments or any trans­ac­tions con­cluded on ex­change.

The con­cern is that the busi­ness res­cue prac­ti­tioner would be able to de­cide which open po­si­tions to close out and which obli­ga­tions to abide by, to can­cel or to sus­pend depend­ing on whether the mar­ket has moved in favour of or against the fi­nan­cially dis­tressed com­pany.

The fear is that “cherry-pick­ing” by the prac­ti­tioner would lead to in­creased sys­temic mar­ket risk. One can imag­ine the re­sul­tant con­se­quences if trades ex­e­cuted on the De­riv­a­tives Di­vi­sion of the JSE by a com­pany which en­ters into busi­ness res­cue pro­ceed­ings be­come un­en­force­able at the sole dis­cre­tion of a busi­ness res­cue prac­ti­tioner. The same mar­ket up­heaval would take place in the over-the­counter mar­ket.

We are of the view that de­spite the anom­aly and de­bate cre­ated by the cur­rent word­ing of sec­tion 136(2) of the 2008 Com­pa­nies Act, the in­clu­sion of the words “sub­ject to sec­tion 35A and 35B of the In­sol­vency Act” can only mean that the mas­ter agree­ments con­tem­plated by those sec­tions and the trans­ac­tions con­cluded on ex­change should ben­e­fit from the ef­fect of sec­tion 35A and sec­tion 35B and should be ex­cluded from the busi­ness res­cue prac­ti­tioner’s far-reach­ing pow­ers.

The same con­clu­sions ap­ply to re­pur­chase and re­verse re­pur­chase trans­ac­tions con­cluded un­der the GMRA (Global Mas­ter Re­pur­chase Agree­ment) and se­cu­ri­ties lend­ing trans­ac­tions con­cluded and un­der the GMSLA (Global Mas­ter Se­cu­ri­ties Lend­ing Agree­ment).

We are of the view that the in­ten­tion of the leg­is­la­ture was to ex­clude mas­ter agree­ments and the cor­re­spond­ing col­lat­eral ar­range­ments from the busi­ness res­cue prac­ti­tion­ers’ pow­ers and to pre­serve the pro­vi­sions of the mas­ter agree­ments and the trades con­cluded on ex­change de­spite one party be­com­ing fi­nan­cially dis­tressed and sub­ject to busi­ness res­cue pro­ceed­ings. There will hope­fully be some clar­i­fy­ing amend­ments in the much an­tic­i­pated Amend­ment Act.

Ei­ther way, the in­tegrity of the pre­and post-in­sol­vency net­ting pro­vi­sions of the mas­ter agree­ments such as the ISDA, GMRA and GMSLA are pre­served, and trades con­cluded on ex­changes will still be closed out and net­ted ac­cord­ing to the rules of that ex­change.

Pic­ture: MORGUEFILE

By cit­ing sec­tions of the In­sol­vency Act in the clause deal­ing with busi­ness res­cue, the dis­tinc­tion be­tween liq­ui­da­tion and pre-in­sol­vency pro­ceed­ings such as busi­ness res­cue, be­comes some­what blurred The anom­aly is that busi­ness res­cue pro­ceed­ings...

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